Why Buying A Refinery Could Be A Disaster For Delta Air Lines (Even With JPMorgan's Help)

Delta Air Lines is eyeing ways to get a handle on rising jet fuel costs, and reportedly talking to ConocoPhillips about buying its refinery in Trainer, Penn.

CNBC’s Kate Kelly reported Wednesday that JPMorgan Chase is now getting involved, and talking about coming on as a financing partner that would pay for the crude oil that would go into the refinery, then selling the refined products to Delta (at around cost) and to the broader market.

Edward Hirs, a professor of energy economics at the University of Houston, says he can think of one reason why Delta would try to get into the refining business: “because they’re stupid.”

“If Delta is concerned about the cost of fuel they can hedge without exposure to the risks of owning a refinery,” Hirs says, which include everything from explosion and spills to labor strife and regulatory issues with states or the federal government.

One argument in favor of the move, as Kelly details, is that Delta’s junk credit rating makes it expensive to hedge fuel costs on the futures market:

the cost of using bank loans to finance futures trades — and the prospect of huge cash margin calls during a crude-market spike — is greater than it would be for a higher-rated company. So that may be another argument in favor of buying a refinery rather than making paper hedges, say industry experts.

Still, if the cost of financing futures trades is the problem, Hirs doubts that buying a refinery will be a successful solution. Unless the airline buys an oil well, it still won’t own the reserves, and relying on JPMorgan to finance the acquisition of crude products doesn’t change that. Delta would be better off buying call options on oil prices if it is worried about jet fuel costs, he says.

Another question is far simpler, why would Delta think it knows more about running a refinery than Conoco, the oil company that is selling the Trainer facility? “The last thing I would want to do is buy an old refinery in the Northeast from someone that knows how to run it,” Hirs says. Conoco “sees this as a way to get rid of a huge albatross.”

The oil company's decision to sell the Trainer facility, announced in Sept. 2011, is unrelated to the split of its upstream and downstream operations and has more to do with its move to unload non-strategic capacity that requires more investment to run that it is worth.

The refiners that have done well lately – rising demand from Japan and China has boosted energy exports – are acting more as merchants, Hirs says, citing Valero Energy as one company having success.

For Delta, which would own the refinery and be the end user, but have no control over the raw material costs, the upside – Kelly mentioned on CNBC that the airline could have easy transport to the New York-area airports it has many flights to – may not justify the risk.

A Delta spokesman declined to comment on any negotiations. JPMorgan did not immediately respond to a request for comment. A Conoco spokesman declined to discuss the sales process on the refinery, but did note that the company extended its deadline for selling or shuttering its idling facility to the end of May after its initial six-month window ended in March.

Delta shares were 1.4% higher at $9.95 Wednesday. JPMorgan was up 2.5% to $44.03 and Conoco added 0.2% to $73.87.

I started covering markets at Forbes in the summer of 2007. Right around then a pair of Bear Stearns hedge funds imploded in the first tremors of the financial crisis, but I swear the recession wasn't my fault. Armed with only a basic knowledge of Wall Street at the start, ...